My E39 is pretty rock solid at 1/4 press great bite, I tried having someone pump the pedal and there is no squelching sound like that coming from the hydraulic block (of the ABS module) - something is not right there I'd imagine. You need to cross check that again with your mates 525i and a few more E39 /38's to be sure, but mine doesn't do that.
Oh and I had a perished rear hose, replaced the four wheel hoses with braided stainless and new fluid - made sweet feck all difference to be honest. I'm on OE pads and discs all round.